30-Year Fixed-Rate Mortgage: An Endangered Species? (Part 1)

The 30-year fixed rate mortgage, the foundation of the American housing market, may be on the endangered species list, thanks to the Obama administration.

Based on recent observations, the Obama administration seems committed to moving American housing policy away from homeownership toward rentals. They would do this by: (a) transforming Fannie Mae and Freddie Mac from GSEs (government-sponsored entities) to GCEs (government-chartered entities); and (b) devoting a significant enough chunk of the funds from the new GCEs into financing multifamily projects. I believe that Wall Street would cheer such a move, as it would open up an enormous new market for finance, backed by the explicit guarantee of the United States.

I also believe that the politics of 2010-2011 are such that these changes are far from unthinkable. In this first of a three-part series, I explain why:
The combination of these policy changes will, I think, result in either the end or sharp curtailment of the standard 30-year fixed-rate mortgage. The new standard for individual families to finance the purchase of their home will be something closer to a 10- to 15-year adjustable rate mortgage, with a significant down payment required by the lender.

That is, of course, precisely what is meant by "sustainable homeownership" -- the policy stance of the Obama-era departments of Housing and Urban Development and of Treasury.

The Steps to Transformation

In various documents, articles on media sites and blogs, and during the recent conference on the Future of Housing Finance, co-hosted by Treasury secretary Timothy Geithner (pictured above), various members of the Obama administration revealed its intentions, at least in broad strokes. The conference's panelists seemed to have been handpicked by Secretaries Geithner and Donovan to push a particular line of reasoning.

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Here's my take on the transformation: First, Fannie and Freddie will be fully nationalized -- no longer private companies seeking to generate profits for their shareholders. The most rational thing would be to merge Fannie and Freddie into Ginnie Mae, the Government National Mortgage Association, which means by D.C. politics that is the least likely thing to happen. Making government involvement in mortgages explicit is the recommendation of folks across the spectrum, from Bill Gross of PIMCO to the National Association of Realtors.

The important change here would be that, as part of the government, the new Ginnie-Fannie-Freddie Mae combined entity (which I hereby dub "Giffie Mae") would no longer seeks to generate a profit for shareholders. Rather, it would seek to further policy objectives.

Second, to advance the policy of "sustainable homeownership" (on which I've written about before here and elsewhere), "Giffie Mae" would start to invest heavily into financing multifamily properties (i.e., apartment buildings). For me, the key to why this may happen came from Alan Boyce, the CEO of Absalon, a joint venture between George Soros and some Danes. Boyce noted that government-backed multifamily securities (in alphabet-soup-land, that's a GSE CMBS) outperform their private-market equivalents, and he praised the Danish mortgage market, calling it perhaps the most successful residential-mortgage-backed securitization platform in the world.

Housingwire.com reported that the GSEs (Fannie and Freddie) "are planning a widespread push into the rental space. In fact, it felt [as if] a solution has already been basically settled on, especially as no representative from either GSE spoke at the Treasury conference."

Third, because "Giffie Mae" (and the Federal government itself) has limited funds -- despite what some people in Washington appear to believe by the way they spend -- it cannot continue to provide the same level of support to the residential mortgage market and to the new multifamily commercial mortgage market, even as a nonprofit government entity. As a result, "Giffie Mae" will scale back support for residential mortgages; no one knows by how much.

Banks will have to decide whether they want to continue selling mortgages, and under what terms, when the secondary market for mortgages might be significantly smaller, thereby raising the risk to the bank of default. What we do know is that Bill Gross, for one, has said that if he were funding mortgages out of his fund he'd want a 30 percent down payment, at a minimum, and short-term, floating-rate loans so that he's not eating interest-rate risk.

Historically, the 30-year fixed-rate mortgage with low down payments -- the engine of growth for the U.S. housing market -- is a creature of federal housing policy. Prior to Franklin Roosevelt's New Deal, most home mortgages required 50 percent down on a five-year loan, with interest rates that reset every year. I doubt that we're headed back that far, but changing the norm from the 30-year fixed with 10 percent down to a 15-year adjustable with 30 percent down does not strike me as impossible.

Consequences for Consumers

It is a fool's errand to predict what the consequences of an event that hasn't happened yet would be. So here I go, one fool at your service!

If these changes come to pass, buyer demand would decrease. The remaining questions are: By how much and where? There are likely to be neighborhoods in which "sustainable homeownership" policies wouldn't be noticed -- wealthy urban and suburban areas with great schools, for example. But first-time homebuyers would need to save longer to afford a large enough down payment and would likely face higher interest rates. It would be more difficult to own a home in America. But then, that's the whole point of sustainable homeownership, isn't it?

For sellers, then, the consequences simply would be a drop in price. The brokers and agents I've spoken to about the hypothetical scenario all seem to believe that if some of the policy proposals pass it would cripple the housing market for years. A double-digit drop in home values in a fairly short period is not unrealistic.

With the resulting upsurge in demand for rentals, rents are likely to rise, especially in major metropolitan areas where development is difficult and costly. It isn't as if there's a lack of demand for rentals in Manhattan, for example; the push by "Giffie Mae" into rental financing would help, but it would take a few years for multifamily housing stock to catch up to the demand that will be unleashed. Over the long haul, with multifamily housing becoming the focus for government support, rents will drop as supply catches up to demand.

What does this mean for you today? Well, speak to your local real estate agent, your financial adviser, or your lawyer. I'm just a blogger-fella on the Interwebs.

Having said that, if you have a 30-year fixed-rate mortgage today, resist refinancing into an ARM. If you're thinking about moving, or buying up because you've outgrown your home, I'd look to do that now before the rules change (if they do). If you're thinking about buying your first home in a few year's time, then it might not be a bad idea to increase your savings by quite a lot. You'll almost certainly need to bring more cash to the deal than in 2010.

Next in the series: a look at what rentals might look like in this fully imagined housing future.

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